Euro Area Economic Outlook June 2017

Euro Area: Eurozone clears political hurdles

May 31, 2017

Recently released data show that the Eurozone economy defied expectations at the start of 2017 and expanded a robust 0.5% over the previous quarter in Q1. The common-currency bloc has managed to shake off multiple preliminary hurdles, most notably a Brexit-induced slowdown that had been previously forecast for the region. The preliminary figure confirms that so far, the recovery has legs, with growth matching Q4’s figure and last month’s FocusEconomics panelists’ expectations.

A breakdown by components is not yet available, but solid consumption and buoyant export growth are likely behind the result. Overall, domestic demand is riding the tailwinds of an improved labor market, a less-tight fiscal stance and ultra-loose monetary policy. A pick-up in global trade is benefitting overseas sales, although import growth is likely eroding any positive impulse from the external sector. In addition, growth across the economies is becoming more broad-based and some of the region’s laggards have experienced improvements in GDP growth, including Belgium, Finland and Portugal.

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On top of the positive incoming data, the Eurozone is clearing political hurdles. Following a turbulent campaign race, centrist Emmanuel Macron beat right-wing Marine Le Pen in the presidential runoff vote on 7 May, ensuring that the region’s second-largest economy remains in pro-European hands. While the domestic policy agenda will be shaped by the outcome of June’s parliamentary vote, the ending of France’s election cycle should facilitate a shift from politics to economic reforms. In Italy, election risks have shifted into next year, while Angela Merkel’s CDU/CSU is the clear front-runner in early polls for Germany’s upcoming vote.

Yet, all is not rosy everywhere in the Eurozone. In the Netherlands, coalition talks have collapsed and a government has yet to be formed after the March vote. The fractured nature of the parliament makes forming a Dutch government a time-consuming process and at least four parties will be needed to reach a majority. Meanwhile, questions persist over how long Spain’s minority government will last or if it will be able to scrape together enough support to rule effectively. In Greece, the country is inching closer to a summer crisis as a standoff over the country’s debt load holds up fresh funds. The country faces a hefty repayment schedule in July. However, our panelists see the Eurozone clearing these hurdles comfortably for the time being and GDP recording another healthy 0.5% expansion in Q2 and Q3.

Economic panorama turns brighter

The FocusEconomics panel held its outlook for the Eurozone unchanged this month, after upgrading it by 0.1 percentage points in the previous publication. The panel sees the economy growing a healthy 1.7% in 2017 thanks to solid dynamics at home and abroad. For 2018, the panel sees GDP growth broadly steady at 1.6%.

Looking at the individual countries in the region, the panorama improved notably this month with nine economies receiving growth upgrades for 2017, including major-player Germany as well as Ireland and Portugal. Nine countries saw no change to their outlooks, while only Estonia was downgraded.

Ireland and Malta are expected to be the fastest-growing economies in the region this year, expanding above 4.0%. On the other side of the spectrum, Greece and Italy will be the region’s laggards, growing at around 1.0%. Among the remaining major economies in the region, Spain will outperform the rest by growing 2.7%. Germany is seen expanding 1.7%, followed by France at 1.4%.

GERMANY | Construction boom fuels healthy growth

The German economy got off to a strong start to the year, according to official GDP figures released by the Statistics Institute on 23 May. GDP growth accelerated and was well balanced, with all main categories accelerating. Most notably, fixed investment growth came in at a multi-year high, thanks in large part to the ongoing construction boom. And while both import and export growth slowed, the overall contribution of the external sector to GDP growth was the highest since Q2 2015, an indication that strengthening global demand is having a positive knock-on effect on the rest of the economy. The positive momentum seems to have carried over to the second quarter, with confidence indicators reaching all-time highs. This bodes well for Chancellor Angela Merkel and her CDU party in the run-up to the September parliamentary elections, especially after having comprehensively defeated the rival SPD in state elections North Rhine-Westphalia in mid-May.

GDP growth should remain robust this year, thanks to a strong external sector and resilient fixed investment. However, higher inflation will weigh on household consumption. Our panel expects GDP to grow 1.7% in 2017, which is up 0.1 percentage points from last month’s forecast. For 2018, the panel also expects GDP growth of 1.7%.

FRANCE | Macron takes the wheel

France turned a page on 7 May after Macron clinched victory in the most tumultuous elections in recent history. His victory discarded any fear that the country would U-turn from economic orthodoxy and European integration. Nevertheless, the president faces an uphill battle. He inherits a deeply divided society and a number of pressing economic issues such as stubbornly high unemployment and anemic growth. The decisive June legislative election is his most imminent challenge and will largely determine how much power he will have during his tenure to pass sweeping reforms. The appointment of many prominent figures from the center-right such as his Prime Minister and Minister for the Economy and Finance, not only hints at the type of reforms he will pursue but is also an attempt to lure voters to his party.

The economy is expected to accelerate this year and next on the back of a recovery in exports and solid domestic demand. The outcome of the 23 April elections have dissipated some fears about the country’s economic course and panelists participating in the FocusEconomics Consensus Forecast expect GDP growth to accelerate mildly to 1.4% this year, which is unchanged from last month’s forecast. For 2018, the panel foresees growth of 1.5%.

ITALY | Growth loses steam in Q1

Italy’s economy is lagging behind its European peers. Recently released data shows that GDP expanded a meager 0.2% from the previous quarter in Q1, less than half the 0.5% growth recorded in the Euro area. Private consumption, which was the main driver of growth last year, is gradually weakening, restrained by rising inflation, a stubbornly high unemployment rate and feeble wage increases—consequence of stagnant productivity. Moreover, the sluggish growth pace is hurting the balance sheets of many Italian companies, making it unlikely that the billions of euros of non-performing loans will be repaid and preventing banks from granting additional credit. However, some positive news came from the external sector, as exports expanded at a solid pace in the first three months of the year, mainly on the back of growing demand from non-EU countries, and likely continued to do so at the beginning of the second quarter, as suggested by the latest PMI reading.

The economy should maintain its lackluster pace of expansion going forward. Household spending is expected to stay soft in the face of a lethargic labor market, higher inflation and political uncertainty, while the external sector should improve slowly and support the manufacturing sector. Analysts expect the Italian economy to expand 0.9% in 2017, unchanged from last month. For 2018, the panel sees growth of 1.0%.

SPAIN | Economy on a tear

The economy continues to build momentum as stronger-than-expected dynamics in the first quarter carry over into Q2. Households continue to benefit from higher real estate prices and robust job creation—growth in Social Security affiliations picked up in April—which so far have prevented the effects of mediocre wage growth and rising inflation from wreaking havoc on private spending. Other leading data points to a better-performing economy, with both the services and manufacturing PMIs accelerating markedly in April and exports expanding at the fastest pace on record in Q1. In line with the improved dynamics, GDP growth for Q1 was confirmed at a robust 0.8% quarter-on-quarter. The strength of the economy will play a critical role in this year’s long-belated budget, as officials expect economic growth to bring about a sizeable increase in tax collection and a hike in social security contributions, which in turn will allow the expected shortfall to meet the EU target of 3.1% of GDP for 2017.

The economy is expected to grow 2.7% this year—unchanged from last month’s projection but up 0.4 percentage points from January’s forecast—driven by a mix of upbeat business sentiment, higher residential investment, resilient household spending and a stronger external sector. Growth is expected to moderate to 2.2% in 2018 as some of the tailwinds that have supported growth fade.

INFLATION | Inflation confirmed at ECB target in April

Complete data confirmed that harmonized inflation rose to 1.9% in April, the second highest reading since January 2013 (March: 1.5%). Robust domestic demand and higher energy prices have led inflation to return to the European Central Bank’s target of close to, but below 2.0%, and sparked an active discourse among policy analysts over when monetary policy could be changed.

The FocusEconomics panel sees inflation of 1.7% this year, unchanged from last month’s forecast. If inflation projections for 2017 materialize, it will represent the highest reading in five years. In 2018, inflation is seen inching down to 1.5%.